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If you can't beat them, join them. That's exactly what a growing contingent of companies unable to match the stock-market performance of real-estate investment trusts are doing.

In recent years, REITs, aided by investors' rabid appetite for income-producing investments, consistently have trumped the broad market. Last year, while the S&P 500 was flat, the FTSE Nareit U.S. index jumped 4.3%. This year, through Thursday, the S&P was up 3.8%; the REIT index, 5.9%. No wonder, then, that companies in industries including digital-transmission towers, data warehouses, private prisons, and health-care facilities are seeking to convert to REIT status. And there are attractive opportunities to play this trend through the shares of companies likely to undergo a conversion.

A COMPANY SEEKING to become a REIT must satisfy two main criteria: It must derive at least 75% of its revenue from rents and other direct real-estate activities, and it must pay out at least 90% of its profits to shareholders as dividends. In return, those profits are untaxed at the company level, and the hope is that yield-focused investors will flock to the shares.

So far, this maneuver has been pretty effective, with the stocks of REIT-conversion plays generally outperforming both in the lead-up to the switch in status and immediately afterward. Before the change is effected, companies must distribute all retained earnings to shareholders in the form of a special dividend.

The most prominent recent conversion is
American Tower AMT 0.37112999316339484%American Tower REITU.S.: NYSEUSD102.77
0.380.37112999316339484%
/Date(1481302480888-0600)/
Volume (Delayed 15m)
:
778589
P/E Ratio
51.91919191919192Market Cap
43591826685.0323
Dividend Yield
2.140077821011673% Rev. per Employee
1639470More quote details and news »AMTinYour ValueYour ChangeShort position
(ticker: AMT), the leading owner of mobile-communication transmission towers, which moved to become a REIT soon after it had used up its tax-loss assets. The switch, effective last Dec. 31, immediately made American Tower the second-biggest publicly traded REIT. Its current market value is $26 billion. The stock gained 14.7% in 2011's second half, after it started the conversion process, and this year has added another 8%.

Jeff Kolitch, portfolio manager at the
Baron Real Estate
Fund (BREFX), says that the average REIT fetches 22 times AFFO, a measure comparable to operating cash flow. At a recent price of around $50, SBA was trading at about 17 times this year's forecast operating cash flow. At 22 times, the stock would be around $66.

At its recent price of $153, the stock was trading around 14 times operating cash flow. Equinix's stated goal is to double revenue and cash flow by 2015. Applying a current REIT multiple on that larger cash-flow number, Kolitch argues that the stock can exceed $400 within a few years.

BECOMING A REIT CAN create complications. Companies with significant non-real-estate revenue might have to form a taxable subsidiary, and there is a chance of conflicts between the entities. More broadly, the towering valuations that REITs now command might not be sustainable over the longer term, especially if interest rates rise, offering good alternative income investments. And the requirement that 90% of earnings be paid out to shareholders means earnings can't be accumulated for future investment, necessitating that still-growing REITs sell equity or debt to buy or build additional properties.

Thus, REIT conversions could backfire down the road. But in the current market moment, the rush to join the REIT club holds rewards for selective investors.